Sunday, June 11, 2017

Introduction to the Real Estate Non-commoditability Market Inefficiency

What I mean by non-commoditability is the inability of some types of merchandise to act like commodities in markets. It's too long a word. Maybe you can tell me the correct word or a better word.

 A long standing obstacle to solving the problem of unaffordable housing is underdeveloped understanding about market pricing. We hold correctly, as amply demonstrated, that we tinker with market pricing (by fixing prices) at great peril. But economic theory also allows for the possibility of the existence of "market inefficiencies", or conditions under which alleged markets produce unsatisfactory pricing. For example, while we view wages and salaries as controlled by an ostensible market, we also observe that large portions of societies persist in working for unsustainably low pay.

Because we plainly see that the results are unacceptable, it is irresistibly tempting, as demonstrated in the case of wages and salaries, to meddle in the alleged market pricing with price fixing such as minimum wage laws.

We are laudably willing to improve the human condition. It's not acceptable to let harmful results continue in perpetuity due (allegedly) to misplaced blind faith in market pricing or due (more correctly) to some misunderstood and possibly as yet undiscovered or unpublished market inefficiency. So we roll up our sleeves and we fix prices as in the case of widespread minimum wage laws and rent controls. Or we don't. And this is currently a seemingly intransigent ideological disagreement. To fix or not to fix? That seems to be the question. And I don't fault the people who are irresistibly drawn to fixing any more than I fault the ones unshakeably persistent in market faith.

But if we are successful in identifying a market inefficiency clearly, we can conceivably tinker with the rules of the game to resolve or mitigate the inefficiency in ways that don't include price fixing. And playing by good rules is what we all like doing best; games with ill-conceived rules are no fun.

To have any chance of identifying market inefficiencies, we have to exercise a bit of humility on both hands. On the one hand, we must allow for the possibility that price fixing really is harmful and that there must be a better solution. On the other hand, we must allow for the possibility that we are currently blind to a harmful market inefficiency that can very appropriately be corrected without price fixing.

For example, in the case of pay deficiency, we might be open to the possibility that there is no real labor market because of a cultural tradition in which a single employer monopolizes each worker's productivity, blurring the boundary between employer and employee and crushing the venerable micro competition and shopping component of the invisible hand that produces "just right" pricing. Then we might proceed to brainstorm tweaks that don't involve price fixing.

And so I am suggesting that there is an inherent attribute of real estate that is biased away from the ideal (or human right) of affordable housing. I call this attribute NON-COMMODITABILITY.

First, let's be clear on what a commodity is and why that matters. Wheat is a commodity. In the market for wheat, individual grains are not appraised and priced, nor are individual bags. At most, they are sampled randomly. To the market, one grain is as good as another of the same grade. And, significantly, anybody on earth can choose to buy grain of any grade. It is abundant, replaceable, and indistinguishable. Wheat can be turned into flour, bread, or a fine sandwich, and there are different markets for each of these. Nobody bemoans a lack of affordable wheat because everybody ostensibly has equal access to the same commodity. Other essential and non-essential commodities, like hard drives, gold, and bicycles, can be similarly described. Non-commodities like works of art and historical documents cannot be similarly described. This does not mean that there cannot be a market for non-commodities. But significantly, non-commodities are not traditionally affordable, nor do we make the mistake of asking markets to assign pricing for essential non-commodities like a river or a spring of water.

Second, let me explain why real estate does not act like a commodity. At first glance, real estate seems to satisfy the requirements to be a commodity. For example, we can subdivide a piece of land into 1,000 lots of similar size and shape, and we can scatter a selection of 5 floor plan home models onto those lots. Then we can let the market determine what they each will sell for. No individual property is significantly different from the other, and market pricing will create an equilibrium between supply and demand. If that isn't a commodity, what is? Unfortunately, this happy scenario breaks down quickly on several fronts. First and primarily, humans are biased against migration, and these properties are not transportable, so the cost of these houses is not equal to all people even initially. Second, these houses are not seen as depreciating supplies or equipment like groceries or cars. And when these houses are mistakenly treated as commodities, the buyers presume they will become sellers, and the houses are seen as major investments. As a result, it is buyer nature to improve each house. The push to increase property values is a venerated cultural value. And as these houses increase in value, they do not only become each one less affordable, but the entire subdivision becomes less affordable. This phenomenon, which is an intentional barrier against perceived ills like the conversion of homes from young family homesteads into rentals and group homes, is called gentrification. Third, real estate is not renewable. When each house in this subdivision becomes unaffordable, a new affordable house does not spring up in its place. This is unlike new wheat always arriving to take the place of wheat that is turned into flour or sandwiches. Gradually, the affordable market disappears and is replaced by an unaffordable market. And this is because real estate is not a commodity.

But what is wrong with gentrification? What is wrong with the disappearance of affordable housing? What is wrong with improving real estate? Those are questions for another day. And I don't have the answers. But everybody needs to live somewhere. And this upward trend in the price of real estate is a feature of the way we treat real estate. This upward trend is not going to change any time soon. Every time a property is sold, the world is rooting for it to be sold at an increased value compare to the previous sale, with no regard to whether this is ultimately sustainable or moral.

I don't know what is the solution to this market inefficiency. Do we outlaw the selling of real estate like we often do rivers and roads? Or do we leave the state out of the problem and form non-profits with the mission of fostering affordability by holding property perpetually for rent? Maybe I just live in a place with perpetual housing shortages. Maybe housing is utterly affordable elsewhere. And maybe I don't know what I am talking about. You tell me.


Jack Lynch said...

If I accept your definition of "commodity" I oppose the concept of commodity entirely as it wrongfully assumes equality, that "one grain is as good as another of the same grade. And, significantly, anybody on earth can choose to buy grain of any grade. It is abundant, replaceable, and indistinguishable."

in reality nothing is equal, variation is ubiquitous.

There are many similarly troubled assumptions throughout, such as "No individual property is significantly different from the other, and market pricing will create an equilibrium between supply and demand."

"When each house in this subdivision becomes unaffordable, a new affordable house does not spring up in its place"

I know that to be untrue, having spent the better part of this year trying to buy a house so that I can "gentrify" it, as well as touring the fantastic results of urban renewal (as well as avoiding the slums that have failed to achieve that dream). Houses do grow, indeed here in Texas they are built at an amazing rate, and the building and improvement of them helps people have the increased income needed to afford them. Finally they certainly vary quite dramatically, as the money I have spent on home inspections has helped me understand.

Thomas Gail Haws said...

There's nothing I know how to offer more about your opposition to the concept of commodity. I have expressed myself fully. Probably we would both have to study the science of commodities more before we had anything useful to say.

You are much more okay with radical relocation than the average human. And for your approach to location and occupation, it's probably a reasonable approximation to consider real estate a commodity, since you kind of like moving around. There is a substantial subset of humanity for which this is true. It's not the majority of humanity. But it's substantial. This essay pleads on behalf of the others.

Many times in my life I have answered the problems of society in my mind by asking why folks don't simply move to where the groceries and houses are plentiful and cheap. Unfortunately, that answer is only correct from a limited perspective. For many or most people, there are strong factors dissuading migration. Seeing the limitations of my favorite answers has been an exercise in empathy.

Jack Lynch said...

You are one of those people who is dissuaded by migration, and who chooses not to buy a house, improve it, and then rent / sell it at a profit. You preach to your choir, while I sing another song, based in an entirely different meter.

I have considered buying property in this country, which is developing and badly in need of renewal. I like to hear their music at doubletime (an option under settings).

Thomas Gail Haws said...

As I said above, my inclination to migrate and my understanding of human migration propensity has evolved from decade to decade. My current understanding might not align with yours or with mine of the past. But I have adopted it as more suitable to the vast throng of sheep that is the majority of humanity. I'm not preaching to a choir; I am channeling the congregation.

I'm all for good landlords holding and developing all the real estate possible anywhere. My observation in this essay is only against actions that drive rents upward.

Jack Lynch said...

I am reminded of a sign at a cheap asian take-out restaurant that read:

"Price will up!"

As much as I might prefer deflation, we have long been headed in the opposite direction. "Buy low, sell high" is one piece of advice I strive to follow, "leave a place better than you find it" is another.

Is it not obvious that quality > quantity and making things better benefits everyone longterm?

Thomas Gail Haws said...

I am confused. You do know I am not talking about deflation or about reduction of quality or about leaving a place worse than you found it. Right?

Jack Lynch said...

We are rarely talking about the same thing Tom, and we almost never see anything from the same angle.

Urban Renewal ("gentrification") is leaving a place better than you found it. Rents going up relates to inflation.